Bank kerfuffle has Canberra mired in its usual confusion

Now that both sides of politics have decided to crack down on the evil practice of price signalling, we might as well ask who does it and why. Some people may not be aware that the biggest price signaller is not the Commonwealth Bank or Westpac or any of the other "evil" commercial banks. The biggest price signaller in the interest rate market is the Reserve Bank of Australia - the one the government owns.

When the board of the Reserve meets on the first Tuesday of each month, it decides whether it wants to move the rate the banks charge each other on overnight loans. Then it announces the rate it wants. The banks act on that signal and move to the targeted rate. If they refused to do so, the Reserve would have to try to produce the desired outcome by releasing or withdrawing funds. But it is quicker and cleaner for everyone to act on a price signal - which invariably happens.

The established practice is that the banks also use the signal to move other rates, particularly the sensitive standard variable home loan rate. When the Reserve announced on Melbourne Cup Day that it wanted to increase the cash rate, there was no reason to put my mortgage up. The bank lent me the money years ago when I bought my home. That money didn't get more expensive to the bank on Cup day. But it got more expensive for me. We have all been conditioned to accept that a price signal from the Reserve Bank justifies an increase in our mortgage rate.

Now, of course, if I was on a fixed rate mortgage then the price would not move. And some have suggested in this current round of bank bashing that we should ban the variable mortgage. So let me take off my consumer hat and make an extremely important point about macroeconomic management. The variable mortgage rate allows the Reserve to tighten and loosen family finances by the issue of a press release. If we all had 30-year fixed mortgages - general practice in the United States - we would be largely unaffected by small movements in the cash rate. It would take a much longer time and a much greater movement to transmit monetary policy to the real economy. In Australia, our arrangements give authorities a sensitive lever. This allows them to be far more effective in stimulating or dampening economic activity.

The difference, or spread, between the cash rate and the variable mortgage rate has varied over time. In 1996 it was 300 basis points (3 per cent).

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By encouraging competition and a bit of jawboning, the spread came down to 180 points and stayed there for about eight years from 1999. When a new Labor government was elected in 2007, the banks took the opportunity to widen spreads. By July 2008 - before the global financial crisis - it had risen to 235 points. Through 2008, smaller operators were struggling while the banks were given government guarantees which gave them a privileged position over competitors. They widened spreads again. Now they are more than 300 points and right back where they were in 1996.

The outrage of recent weeks has not been that the banks acted on price signals but they acted outside price signals.

When the Reserve gave a price signal of 25 points on Melbourne Cup day, the Commonwealth Bank moved its rate by 45 points - nearly double. It has been unable to explain why in any convincing way. For a bank that is prepared to pay $16 million salaries it is surprising that it cannot supply anyone who sounds credible on this issue in the media.

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Yet all is not disaster. In the midst of this public outrage over banks, the Competition and Consumer Commission helpfully suggested an increase in its powers - to combat price signalling. And, of course, with new powers it will need an increase in its budget.

Do you think this will fix the problem? Do you really think bank executives are sitting around reading transcripts of each other's media interviews looking for coded messages about what to do next on interest rates? Apart from everything else, this debacle teaches us that bank executives are hardly canny media operators.

So the public is outraged that a bank has thumbed its nose at the price signal. The Parliament steps in with legislation. The regulators get new powers and a bigger budget. Little fish get caught. And the banks remain unaffected. Business as usual in the national capital.